Objectives of Financial Management
Maximizing Organizational Financial Strengths
In a non-profit organization, donations, endowments and other sources of funds must be
efficiently used to meet the mission. In a for-profit organization, equity, financing and
other sources of funds must be carefully used. The published mission of a corporation
may be about selling the best possible product or to be an industry leader. But the
underlying reason for these missions is to maximize the financial value of the
corporation. This maximization gives the corporation ongoing funds with which to meet
the mission. Because corporations are owned by shareholders, an increase in the
financial value of the organization translates to an increase in price per share, or
increased shareholder wealth. It follows then, and is commonly agreed, that through the
efficient use of corporate resources, the objective of corporate financial management is
to maximize shareholder wealth.
Let’s consider two strategies to accomplish this:
Present value of future cash flows
One strategy to maximize shareholder wealth is to maximize the present value of future
cash flows. All managers in an organization contribute to cash flows. The sales manager
oversees maintaining or increasing revenue, the production manager oversees controlling
production costs, the human resources manager oversees training to improve the efficiency
of employees’ work. The cumulative work of all managers to improve cash flows yields
higher revenue and lower costs and, ultimately, higher income to be returned to the
shareholders or reinvested in the organization.
Return on shareholders’ investment
Another way of looking at this is to maximize and sustain a superior rate of return on
the shareholder’s investment. Corporations must continuously develop and improve
the business strategy, looking for product and production innovation, new uses of
technology for all aspects of the business, and cost reduction. This continuous
improvement is aimed at using shareholder investments as efficiently as possible to
yield the highest possible return.
When superior returns are created and the present value of cash flows is
maximized, profit may be realized and two things can happen:
● The profit can be distributed to the shareholders.
● The profit can be reinvested in the business, thereby increasing the price of the
shares held by the stockholders.
Either way, the value of the organization has increased and the shareholder has
benefited from the growth. This is maximized shareholder value and is the primary
goal of corporate financial management.
FP&A’s Role
The FP&A professional’s role in the maximization of shareholder wealth is to help
managers collect, analyze and understand financial data in a way that allows them to
make good decisions on how to maximize the present value of cash flows and create a
superior return on investment. Among other contributions, FP&A uses profitability and performance analysis to assist with deciding:
● How to increase or find new lines of cash flow
● How to shorten the delay in receipt of a cash flow
● How to reduce risk associated with a cash flow
● Which assets to invest in
● How to finance assets
● How to operate assets efficiently
Corporate Finance
Activities
● Financing. Obtaining the funds to support the organization
and its endeavors.
● Investing. Using the funds obtained as efficiently as possible to produce the
highest possible returns.
● Dividend payout. Deciding what to do with of any resulting profits.
Financing
Financing decisions focus on how the organization is funded. Much of the money to
fund an organization comes from the profits that are earned and retained. The rest of
the funding comes from debt or equity. The decision of how to acquire funding must
accommodate both long-term and short-term funding needs. A variety of funding
strategies are available; equity in the form of stocks can be issued, bonds can be
issued, loans or long-term leases can be obtained.
For any organization, a critical decision is related to the level of external financing it will
use. In a simple, sole proprietor small business, the decision may be to use as little
outside capital as possible, relying primarily on personal savings and operational cash
flows for financing and growing the business. In a similar example, a small charity may
decide to provide services only to the extent that it can raise donations.
In both of these examples, the financing decision was essentially not to use external
sources of funding for the organization. Most large organizations, however, will need to
look to outside sources (usually in the capital markets) to raise the funds necessary to
start and to grow. The financing decision for these organizations, therefore, is related
to how much funding is needed, when and in what form it should be obtained, and,
ultimately, how fast the organization will grow.
Once the decision has been made to use outside funding in an organization, decisions
must then be made regarding the use of short-term versus long-term financing and, for
a corporation, the use of equity. Organizations generally want to raise funding, or
capital, at the lowest cost, and there is a capital structure mix that theoretically will
minimize the overall cost of funds. Capital structure will be discussed further later in
this section.
The treasury function of an organization typically plays a significant role in short-term
financing activities.
Treasury Management and Liquidity
In the short term, treasury management is the process of managing the organization’s
liquidity and cash position to ensure the availability of adequate cash resources to
sustain the organization’s ongoing operational activities. (In the long term, treasury
professionals perform critical finance functions that ensure the availability of funds
necessary to sustain the initiatives that support the organization’s long-term financial
objectives.)
The short-term treasury management objectives of managing liquidity are closely
related to the organization’s operating cycle. The operating cycle represents the flow of
funds through an organization. It is defined as the period of time beginning with the
agreement to purchase raw materials, through the production cycle and sale of
products or services, to the collection of payments from customers. This is basically
the time it takes to convert the organization’s cash into the saleable product and back
into cash. Exhibit I.A.1-2 is a graphic depiction of the operating cycle of a
manufacturing organization.
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